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IR35: Umbrella companies could be costing you & acting illegally – are they evading tax?

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IR35 changes will be arriving from April 2021 following a long period of consultation and debate. The changes from HMRC mean that off-payroll workers should be treated as full-time employees and as such, from April 6 medium and large businesses will be responsible for setting the tax status of contractors they hire, mirroring a system that has been in place in the public sector for the last four years or so.

However, despite the Government’s best efforts, the changes they’ve made have proven to be controversial and Robert Thompson, a Legal Executive at Umbrella Reclaim, broke down the history of IR35 and what’s led to the current pushback it’s facing from the private sector: “IR35 was introduced in April 2000 and it was the Government’s intentions to clamp down on the growing use of Personal Service Companies (PSC) being used by contractors who were trying to exploit the fiscal advantage offered by a corporate structure.

“The purpose of the legislation was to treat employees who work like employees but through their own PSC, pay similar taxes to other employees.

“The mistake the Revenue made was to let the contractors working through their PSC’s determine their own status. This was addressed in 2017 when changes were made to the IR35 rules for those working in the Public Sector.

“These changes took away the contractor determining his/her status and passed this onto the client. These changes were meant to be adopted in the Private Sector in April 2020, but due to the onset of Covid it has been delayed until April 2021.”

READ MORE: HMRC warning: IR35 tax changes set to harm the self-employed

Eventually, large organisations took action in advance of the alterations and umbrella companies began to emerge.

In short, umbrella companies are set up as a standard limited company and are operated by a third party who acts as an “employer” on behalf of its contractor employees.

Recently, Rebecca Seely Harris, an Independent Employment Status, Off-payroll and IR35 Expert and former Senior Policy Adviser with HM Treasury’s Office of Tax Simplification (OTS), spoke with Express.co.uk to explain how these umbrella companies work: “An umbrella company will employ you for onward supply to the end client. You are in reality an employee of the umbrella company and the benefit of this to the end client and the agency, is that they are protected from tax claims and employment rights issues.

“The downside is that as an employee of the umbrella you will have employee national insurance contributions deducted alongside income tax. What you probably don’t know is that the umbrella will also deduct the employers’ NICs from your wages as well and that is an additional 13.8 percent. You should, however, be paid holiday pay and sometimes this is ‘rolled up’ and paid along with your wages. Whether this is technically legal or not is still up for debate.”

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This legality is a point of contention with Umbrella Reclaim, as Robert continued by detailing large companies started to prepare for the changes in April 2020, forcing contractors out of their PSC’s and into umbrella companies.

Robert explained: “It is my considered opinion these Blue Chips and Banks conspired with their Agencies to take this action in an attempt to avoid incurring Employers National Insurance and Apprenticeship Levy, because under the rules the ‘Fee-Payer’ is the person responsible for these costs and this would have been the Agency if they continued to engage with PSC’s. They obviously went to the client, saying they would have to bear these costs and as such, would have to accordingly increase their rates to cover this.

“So as I said they conspired between them by forcing workers out of their PSC’s and into umbrella companies who would replace the Agency as the Fee-Payer. Umbrella companies obviously pay this cost, but this cost is passed onto the contractor which is totally unlawful, because the Social Security & Benefits Act 1992 prohibits the direct or indirect recovery from employees of employer’s National Insurance Contributions (“NIC”). This includes employer’s Class 1A NIC due on benefits in kind also.

“The Employment Rights Act 1996 also adds additional protections for workers. It states workers must not suffer deductions from their wages unless the deduction is required, authorised by statute or by the worker’s contract (which won’t apply here); or the worker has given their prior written consent to the deduction.”

Robert broke down the technicalities of the legislation and illustrated how umbrella companies are costing the nation: “Now moving onto matters more serious, all these umbrella companies are perpetrating Tax Evasion, and all parties in the chain need to consider the consequences of the Criminal Finance Act 2017. So let’s take a look as to exactly what is happening in the context of the evasion.

“The Off-Payroll Rules (IR35) falls within Chapter 10 Part 2 ITEPA 2003 requires Employment Taxes to be paid on the Deemed Direct Payment or Chain Payment. A chain payment is defined under Section 61N of the legislation, which is a payment, or money’s worth or any other benefit, that can reasonably be taken to be the workers’ services to the client.

“Now let’s examine the chain payment in the framework of the Legislation, using the Client insisting on the workers using the services of an umbrella company.

“The Client pays the Recruitment Agency the sum of £1,150 for the services of the Worker. The Recruitment Agency then remits the sum of £1,150 to the umbrella company. The umbrella company from the monies it receives, deducts what they deem to be ‘Company Margin’ and this will generally be their fee and Employers Costs, which in the example I give below totals £148.17. The worker then receives a Gross Payment of 1001.83 from which PAYE is then applied.”Robert provided the following example of how this would work in practice:

  • £1,1150 gross: tax = £219.55, Employees NIC’s = £97.23, Employer’s NIC’s = £135.38, totals: £452.16
  • £1,001.83 gross: tax = £160.28, Employees NIC’s = £94.27, Employer’s NIC’s = £114.93, totals: £369.48

Robert continued: “The Weekly Loss of tax revenue is £82.68 and the annualised loss is £4,299.36.

“I have not factored in the cost of Apprenticeship Levy or indeed Employers Workplace Pension Costs, which would just add to the loss, as tax relief will be received on these deductions.

“Using the example above and given there are circa 1.2 million umbrella workers in the UK, with this number is rising daily due to the actions being taken by clients and agencies since October 2019, based upon the 1.2 million workers and using my example as the average because workers using umbrella companies salaries range between £25k at the low end to £150,000 at the top end, it’s not unreasonable to assume the average pay is £50,000, then this loss to the Exchequer is circa £5billion a year.”

Robert concluded by examining why he thought this is tax evasion, which is illegal, as opposed to tax avoidance: “Tax Avoidance and Tax Evasion are both mechanisms used to avoid or reduce the amount of tax that is due.

“The main difference between the two is Evasion is illegal and Avoidance is legal, albeit many would argue that Avoidance is unethical in this modern era. The Courts have held that claiming a false deduction, which is exactly what the umbrella company is doing in the example I highlighted above, is avoiding the payment of the correct tax and this does fall within the ambit of Tax Evasion rather than Avoidance which in turn has implications under the Criminal Finance Act 2017.”

In response to these IR35 claims and criticisms, an HMRC spokesperson said: “Some companies which engage contractors may choose to do so through agencies or umbrella companies and, as made clear in HMRC guidance, it is legitimate for umbrella companies to deduct employers’ national insurance contributions from the payment they receive from the recruitment agency.”  

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